Market-beating Funds Are No Big Deal This Year

CHET CURRIER Fund Watch

If you happen to hear a mutual fund manager boasting of beating the stock market in 2005, temper your enthusiasm.

Yes, that may come as welcome news. But no, it won't qualify as a rare or astonishing feat.

Approaching year-end, the average among more than 4,000 stock funds tracked by Bloomberg has trounced the Standard & Poor's 500 Index, the stock index most commonly used as a performance measuring stick. Through the end of last week, the average equity fund was up 10 percent, while the S&P 500 had gained 6.4 percent, including dividends.

Since the S&P 500 may be viewed as a United States rather than a world stock index, suppose we confine our sample to domestic growth, growth-and-income and value funds. Even then, the average fund still prevails, up 8 percent.

All this continues a trend that was well under way as the year began. Over the last three years, the average stock fund has gained 18.6 percent a year, according to Bloomberg data, while the S&P 500 returned 13.7 percent a year. In the last five years, the funds averaged a 4.7 percent annual gain while the index edged up 1 percent per annum.

Charts and graphs from 2005 may seldom be seen in all those textbooks describing how fund managers in general can't beat the market. Surprise! Not only have they been doing just that of late, they have made it look almost easy.

Cheery as this news may be for many a fund investor, it can tempt us to draw unwarranted inferences.

First of all, no matter what appearance it may present, the funds' impressive showing hasn't come easy. Overall progress has been grudging at best in the markets, and even the most favored sectors of the market have been subject to sudden chill winds. Witness the 14.3 percent decline suffered by the Fidelity Select Construction and Housing Portfolio from early August to mid-October.

Compelling reasons have abounded to shy away from stocks, ranging from interest rate increases by the Federal Reserve to long spells of sluggish behavior by the stock market itself.

Second, a fundamental common-sense principle of investing hasn't been repealed. It remains impossible for all participants in a market collectively to beat that market. The average result will inevitably be average, and no more than that.

If the average return achieved by market participants manages somehow to exceed the showing of a market index for a sustained period, that may say more about the idiosyncrasies of the index than about the superior skills of the average investor. Get a better index, the random-walkers will say, and we will correctly see once again that investors as a group can't beat the game.

Now, to make a truly fair comparison between funds and an index such as the S&P 500, we shouldn't use a simple average of all the funds. Funds with a lot of assets ought to carry more weight, proportionately, than smaller ones.

Yet in one group of big funds, a clear majority beat the S&P 500. Among 66 U.S.-based stock funds with assets of $10 billion or more, 47 had year-to-date gains through the end of last week that exceeded the S&P 500's.

Many of these winners focus on something other than the big U.S. blue chips that dominate the S&P 500. Some go the international route, others concentrate on small- or mid-caps. Indeed, specialized index funds in those niches proved just as able as managed funds to beat the S&P 500.

So a skeptic can say the preponderance of market-beaters was a fluke. It just so happens that the big stocks in the S&P 500 have been suffering through a long cold spell, making everybody else look good.

My question is, isn't that what investing is all about -- being in the right place at the right time? If you define the terms of the game so that picking your spots doesn't count, no wonder it comes out as no contest.

Chet Currier is a Bloomberg News columnist. He can be reached at ccurrier@bloomberg.net.